It has been common practice for an owner-manager of an incorporated business to "bonus-down" the active taxable income of his/her company to the small business deduction (SBD) limit. If the owner-manager required additional personal funds, the funds were often withdrawn from the company by way of a dividend. For many years, this has been a routine strategy since the high corporate tax rate on income above the SBD limit resulted in a large amount of overall tax being levied on an eventual distribution of these funds as a dividend to the owner-manager. By using this strategy, the company was able to minimize the rate of corporate tax that was applied to its earnings, and the owner-manager was able to maximize his/her after-tax income that was drawn from the corporation.

Going forward, this strategy may no longer be routine. In Ontario, corporate tax rates for active income both at and above the SBD limit have recently decreased, and the rate for active income above the SBD limit is scheduled to continue to decrease through 2013. Presently, for income above the SBD limit, the overall tax rate in Ontario (corporate and personal) applied on corporate earnings withdrawn as a dividend is now only marginally higher than the overall tax rate applied on a bonus withdrawn from the corporation.

As corporate tax rates decrease, the tax deferral opportunity increases for corporate earnings that are not distributed as a bonus to the owner-manager. The deferral available in Ontario on taxable income above the SBD limit for 2011 is approximately 18% (growing to approximately 21% in 2014). Generally, if an owner-manager does not require personal cash from the company, the company should not automatically "bonus-down". As a result, the corporate earnings will benefit from the growing tax deferral. If an owner-manager requires personal cash from the company in the future, a bonus (or a dividend) may be paid at that time.

By 2013 in Ontario, the overall tax rate applied on corporate earnings withdrawn as a dividend will be marginally lower than the overall tax rate applied on a bonus withdrawn from the corporation. At that time, it is expected that an owner-manager will compensate themselves through dividends (consideration should be given to pay a salary to maximize RRSP contributions or to utilize child care expenses).

There are various points to consider from the company's perspective if it ceases to use a "bonus-down" strategy, including:

  • being mindful of maintaining the small business corporation status as funds build up in the corporation,
  • reviewing the cash flow impact as a result of increased tax instalments, and
  • determining how the company's scientific research and experimental development expenditure limit will be affected.

If an owner-manager requires personal cash and must draw funds from company, the following tax-free distributions may be considered, if available:

  • repaying shareholder loans,
  • returning share capital where possible,
  • paying dividends from the company's capital dividend account, and
  • creating a shareholder loan by transferring personally held assets to the company on a tax-deferred basis.

It is important to keep in mind that no "one size fits all" approach exists when determining the optimal owner-manager remuneration package. Each owner-manager's specific needs and objectives must be carefully considered when determining an overall compensation package.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.